Tax law panel may look to drop dividend distribution tax (DDT)
October, 01st 2018
Members of the task force set up to draft a new direct tax legislation appear to be in favour of abolishing the dividend distribution tax (DDT). The panel may revert to the classical method of taxing dividend in the hands of shareholders. One of the objectives is to boost investments from abroad, as DDT casts a heavy burden on foreign investors, sources close to the developments told TOI.
Abolition of securities transaction tax (STT) to eliminate double taxation may also be on the cards, as Budget 2018 introduced tax on long-term capital gains exceeding Rs 1 lakh on sale of listed securities. The committee led by CBDT member Arbind Modi is expected to submit its report to the finance ministry in the coming days. It is unclear whether it will be made available for public comments.
Currently, an Indian company declaring dividends has to pay DDT at the rate of 20.55% (including surcharge and cess). Dividend income is tax-free in the hands of foreign shareholders. Certain tax residents of India, such as individuals, Hindu Undivided Families (HUFs) and firms, having dividend income aggregating to Rs 10 lakh or more, have to pay tax at 10% plus surcharge and cess.
The task force examined the mechanism for taxing dividends across countries. While India’s mechanism of DDT was drawn from South Africa, the latter abolished this system several years ago. With countries also lowering their corporate tax rate — for instance, US lowered it from 35% to 21% — it was felt that the maximum marginal rate for India Inc of 35% (for companies with a turnover of more than Rs 250 crore) and the DDT of 20.55% is onerous.
Foreign tax credit (FTC), which is a credit in the home country (that is, in the country of the investor) for taxes paid overseas, is challenging to avail in respect of DDT. Major investor countries in India such as Singapore, Japan and the UK — adopt a territorial tax regime and foreign dividend is not taxed. After recent tax reforms, dividends from a foreign subsidiary are exempt in the hands of a US company, subject to meeting a 10% ownership requirement.
As foreign dividend is taxfree, FTC is not available in these countries. In such cases, DDT is a heavy sunk cost for the parent or affiliate investor company. Participation exemption clauses in several EU countries entail that a significant portion of foreign dividend is exempt in the hands of shareholders of such countries. FTC is available, but only to the extent it relates to taxable foreign income. Other countries, such as Mauritius or Australia, tax foreign dividend but grant an FTC for the taxes paid in the source country (eg, India).
As DDT is levied on the Indian company and not on the shareholders who receive the dividend, claiming FTC generally poses difficulties or requires meeting of certain conditions. Underlying tax credit (for DTT) can be claimed in Mauritius by investors who meet certain threshold norms in the Indian investee company. “Even overseas individual investors, say a green card holder who has to pay tax on his worldwide income in the US, suffer. While DDT is an indirect burden borne by them, they do not get or find it difficult to get an FTC,” says Gautam Nayak, tax partner at CNK & Associates.
“Removal of DDT and its replacement with withholding tax will benefit international investors significantly. First, the rate of withholding tax under many tax treaties is low — typically at 10%. Second, the ambiguity that exists today on whether DDT is available as a credit in the home country of the foreign investor will go away,” says Abhishek Goenka, tax expert.
“Most foreign shareholders will be able to claim an FTC for the taxes withheld in India. The lower withholding tax rates will also result in enhanced dividend payouts and boost investor sentiment,” adds Punit Shah, partner, Dhruva Advisors.